Stocks Getting Scarce as Fed-Driven Rally Sees No End

Easy monetary policy by the Federal Reserve and other central banks is limiting supply of stocks, as well as fueling asset bubbles, analysts warned on Monday.

"We do not think investors fully grasp the degree to which the Fed's easy money policies are helping limit the supply of shares and boost the demand for shares," said David Santschi, the CEO of TrimTabs Investment Research, in a note on Monday. He explained that the liquidity-driven rally, which gathered pace in January, is encouraging companies to limit the supply of outstanding shares.

Santschi added that lower borrowing costs are making stock buybacks (companies reacquiring their own stock) attractive, and pushing companies to issue new debt rather than new shares.

"We are in an environment of low growth, interest rates are very low. Why wouldn't corporates take advantage of these low rates, tight spreads to borrow at the moment. That is in many ways the objective of the current policy framework," Alan Capper, managing director at Lloyds TSB Corporate Markets told CNBC on Monday.

"The equity market is shrinking and that is part of the reason why it is rallying so much. But then bear in mind, because sovereigns are issuing less debt, so is the fixed income market as well. So when it looks like you see corporate debt rallying, when it looks like you see equity rallying it's actually scarcely of assets out there."

However, Jonathan Compton, managing director at Bedlam Asset Management, noted that stock valuations remain low according to indicators such as the price-to-earnings ratio. The S&P 500 price-to-earnings average ratio currently sits at around 16.5, a far stretch below the peaks seen before the technology bubble burst in 2000, or Black Monday in 1987.

"If this changes, the Fed would have to act by slowing or stopping quantitative easing (QE), unless deflation loomed at the same time. Then we would all be in trouble," he said in a research note on Monday.

However, Shepherdson added that the market impact of Fed bond purchases had been stronger than expected, and said he had raised his outlook for the Dow Jones Industrial Average (Dow).

"Anyone who goes to buys stocks that have doubled, let's say since Christmas...you are smoking something fairly illegal," Compton concluded.

The Fed announced in December that it would buy $45 billion in additional Treasurys every month, on top of the $40 billion a month in mortgage-backed security purchases to which it was already committed. The Bank of Japan has also made an open-ended commitment to asset purchases and the Bank of England has made similar moves.